August 10, 2009

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Article

Under Scrutiny

Federal Regulations Change Corporate Board Governance

By Marie Mischel

August 10, 2009


Years ago, the CEO of a public company could pack his or her board of directors with cronies who would do his or her bidding or face the heave-ho from the man in the big chair. Today, federal regulations dictate that directors, including those in key seats, such as auditing and the nominating and corporate governing committees, stay independent of the CEO. The rule came about after the dot-com meltdown that resulted in the passage of the Sarbanes Oxley Act of 2002. This federal legislation introduced significant changes in the oversight of public companies’ financial and corporate governing practices, but “compliance with the legislation need not be a daunting task,” according to the Website, www.soxlaw.com, which outlines the act’s requirements. However, company directors say this federal oversight has meant increased accounting and attorney fees to ensure compliance. And, as a result of the recession, public companies are facing even more public scrutiny in addition to new legislation such as TARP (the Troubled Asset Relief Program). TARP is Not a Warm Blanket Howard Headlee, president of the Utah Bankers Association, says the intense scrutiny of corporate America that began with Sarbanes Oxley has dramatically changed governance in the banking industry. “It has blurred the line between governance and management, which is not healthy,” he says. “I don’t believe it’s the role of government, nor is it healthy for the free market to have this level of involvement.” The federal legislation does increase the transparency of corporate governance, which is a good thing, Headlee says, but the negative aspect is how it involves the government in setting company policy. The regulations force directors to be more involved with the company’s day-to-day operations. Many Utah banks did not accept the money offered recently by the federal government because of the stigma surrounding it, Headlee says. Though the funding came through the Capital Purchase Program (CPP), which offered capital to healthy financial institutions rather than to struggling companies such as AIG that received TARP money, public perception tarred them all with the same brush. The CPP funding was meant to stimulate the economy by increasing the availability of credit, Headlee says. “But there are too many strings attached and there is now a rush to pay the money back. Healthy companies, quite frankly, don’t want increased government regulation in the operation of their company.” Bailouts are Not for Everyone The federal government isn’t in the business of bailing out failing businesses, maintains Senator Bob Bennett, (R-Utah). The auto companies and the banks are obvious exceptions to the rule because their failure posed a risk to the entire country, he adds. Nevertheless, Bennett’s anxious to divest the government of its holdings in General Motors. With two other senators, he proposed an amendment that would give the government’s stock in GM to taxpayers within a year. He doubts the amendment will pass, but says that the public’s revulsion at the idea of the government running a public company is high. Out From Under the Microscope The public outcry at the bonuses paid to AIG executives and the salaries given to executives of failing companies has led the federal government to clamp down on pay, at least for companies that receive bailout money. This could be counterproductive, say local experts. “My own personal opinion, based on lots of business experience, both as an attorney counseling clients as well as a director of a company, is that over time all of the best people leave,” says Ron Poelman, president of the Utah Chapter of the National Association of Corporate Directors. Poelman, who has been a corporate securities attorney for more than 25 years in Silicon Valley and Utah, is a partner with the law firm Jones, Waldo, Holbrook & McDonough, where he heads the Corporate and Securities Practice Group. “Over time what happens is the people who are the most sought after and usually the most capable and the most successful and with the most ambition end up getting the good jobs in places where they’ll pay them more,” says Poelman, who also sits on the board of USANA Health Sciences. As a result of this talent exodus, companies over time will perform more poorly, he says. “There’s not always a direct correlation [between executive talent and performance], but generally speaking, over time the companies that have the most ambitious and thoughtful and aggressive and intelligent, inventive executives will generally perform better than those who don’t.” This puts boards in an impossible situation, he says, since directors have a fiduciary obligation for the shareholders to maximize shareholder value. One way directors do that is by hiring the right executives to drive that value on a day-to-day basis. But if directors need to limit executive pay, an excellent CEO or CFO candidate may accept a better offer from a competing company. Poelman explains that in general, government regulation increases the cost of doing business by putting American companies at a competitive disadvantage with many of their foreign counterparts. Hence, the new rules under Sarbanes Oxley, and future rules that will affect public companies, are actually driving smaller companies out of being public, which are either going private or are selling themselves off to other companies. “Certainly in Utah, that’s the case, and you can see that trend across the nation,” he says. Pre-emptive Strike When the economy crashed, the federal government looked to public companies for accountability. The National Association of Corporate Directors (NACD), a nonprofit organization that offers training for corporate directors, responded in March by asking boards nationwide to implement 10 corporate governance principles, including accountability and transparency. “We believe that there has been erosion in public confidence,” says NACD President Kenneth Daly. “The principles are not meant to be a prescription, they’re meant to be a roadmap. We want to address transparency, compensation, risk and the board’s role in strategy.” NACD also released white papers that identified emerging problems and new best practices. The effort has drawn a huge response with more than a billion Website hits, 1,500 downloads of the principles and white papers, and hundreds of phone calls, Daly says. Aetna, UnitedHealth and Home Depot are companies that have already adopted the principles, In addition, NACD members have met with key congressional members to discuss the principles. Poelman says the idea behind the drive for companies to commit to these principles is to show that there isn’t such a need for prescriptive regulation from the government. “The government should allow all companies—public, private, nonprofit—to govern themselves and not always have government tell them how they should be governed.” David B. Winder, board chair of the NACD Utah Chapter, agrees. “The 10 key principles are largely a consolidation of the best literature and the best practices that were already out there.” On the Horizon Federal lawmakers are considering several proposals to further govern public companies. Among those is a bill that would require independent directors to be board chairmen, says Winder, who also sits on the boards of Energy Solutions, GE Capital Financial and the Utah Retirement Systems and Public Employee Health Program, among others. The proposal to prohibit a company’s CEO from serving as chairman of the board isn’t sound business practice, he says. “[That is] because the CEO knows the business best, knows the employees best and it’s the CEO who has to really develop the strategy for the company.” Another proposal being considered on Capitol Hill is “say on pay,” which would allow shareholders to vote whether they agree with executives’ compensation package. “It sounds good and it will get some press and notoriety for the particular congressman who proposed this. To the layperson it sounds great. But in practice, it’s just silly,” says Poelman. Despite these and other proposals, Bennett says he doesn’t see any further legislative action regarding corporate governance. “I won’t say absolutely not,” he says. “In this atmosphere, you never can predict exactly what’s going to happen.” As for NACD’s 10 key principles, he doesn’t believe they will be the basis for legislation, either, but helpful if somebody does initiate further legislation on corporate governance. Where They’re Headed Several trends are emerging for corporate directors. They are being much more communicative with shareholders and committed to keeping shareholders informed about what’s going on, Poelman says. In addition, “I think executives in all corporations in America over time will make less money because there’s so much scrutiny of high compensation of executives that I think boards and compensation committees will be pressured to try to keep the salaries lower,” he says. Winder sees an increased emphasis on risk management, which is going beyond the financial realm and into areas such as safety. Boards need to be aware of how to address these issues so they’re confident that the most important risks are being addressed, Winder says, and these vary tremendously from company to company. “You have to be able to sort out the most important risks and you have to ask tough questions about how those risks are being managed and the area’s getting a lot more emphasis.” He also says it’s a problem when companies fill board seats with expertise from outside the industry because those board members may not have enough industry expertise and experience to give good advice to CEO management on strategy. Staying on Top With the myriad of responsibilities facing corporate directors, continuing education is paramount. Poelman recommends that directors join a professional organization such as NACD or enroll in programs such as those offered by Harvard and Stanford universities. Continuing education on current issues is necessary for board members, as is institutional knowledge, Winder adds. They also should know the best practices for board duties, corporate governance and how to be a good director. “A good director should have eyes in, but fingers out,” he says. “The director’s role is oversight. Management’s role is running the enterprise. But probably most important of all is to dig in and understand the company. Understand its values, its strategies, how it handles risk and understand the competition. Have a broad overview of the industry—and that takes a lot of time and energy. But every board member needs to do that.”
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